draining development.pdf - Khazar University

212 Draining Development?Transfer Price Manipulation and Government RegulationsCorporate income taxes and transfer price manipulationThe most well known external motivation for manipulating transferprices is the differences in CIT rates between countries or between stateswithin countries. For evidence on tax-induced motivations for TPM, seeLi and Balachandran (1996); Eden (1998); Swenson (2001); and Bartelsmanand Beetsma (2003). There are several ways to engage in TPM insuch cases:• The MNE can overinvoice tax-deductible inbound transfers intohigh-tax countries and underinvoice them into low-tax countries.This shifts corporate profits from high-tax to low-tax jurisdictions.Examples of inbound transfers include imported parts and components,payments for engineering and consulting services, and royaltypayments for intangibles.• The MNE can underinvoice taxable outbound transfers from hightaxcountries and overinvoice them from low-tax countries. Thisshifts corporate profits from high-tax to low-tax jurisdictions. Examplesof outbound transfers include exports of finished goods, chargesfor the provision of services to other parts of the MNE network, andlicensing and royalty payments for outbound intangible transfers.• If the home government allows deferral of CITs on MNE foreignsource income, the MNE can avoid the home country CIT on foreignsource income by not repatriating foreign source earnings to thehome country. The funds can either be reinvested in the host countryor moved to another country in the MNE network.• If the host country levies a withholding tax on the repatriated profitsof foreign affiliates and the withholding tax is not fully creditableagainst the home country tax, not repatriating foreign source incomeavoids the tax. In these cases, the MNE can use the rhythm method totime its repatriated earnings only in tax years when the withholdingtax is fully credited against the home tax (Brean 1985). In other years,no profits are remitted to the home country.• If withholding taxes vary according to the form of repatriation (forexample, management fees, royalty and licensing payments, and dividendsare typically subject to quite different withholding tax rates),the MNE can move the funds out in the form that incurs the lowest